IT SERVICES 19 February, 2021 ITE (Neutral tp NOK13): Attractive earnings growth profile offset by 21e P/E of ~20.5x for now Petter Kongslie SpareBank 1 Markets Phone : (+47) 24 14 74 96 Phone : (+47) 2414 7400 Mobile : (+47) 98 41 10 80 Visit address : Olav Vs gate 5, 0161 Oslo E-mail : [email protected] Post address : Post-box 1398 Vika, 0114 Oslo Attractive earnings growth profile offset by 21e P/E of ~20.5x for now We reiterate our Neutral rec. and NOK13 target price based on limited 2021/2022 estimates We reiterate our Neutral rec. despite potential for revenue growth, margin expansion and dividends, as we find this reflected in the premium multiple to peers. Indeed, while core digital services gross profit grew 14% (12.1% YTD) from among other access to the worlds 4th largest IT pool with # of employees end-of period up 13 QoQ (63 YoY), this revenue stream make up ~80% of revenues. Data center transformation (~20% of revenues) continue to weight on EBIT margins (2.9% margin YTD vs. blended EBIT margin of 10.1%), meaning gradual margin improvement with transformation to cloud that will accelerate next 6-12 months (99% of revenues will come from core digital business as of 4Q21). Coupled with trailing 12m FCFE per share of ~NOK0.8, consistent high distribution is also sustainable (NOK0.75 this year). However, when peers with similar 2021 EBIT margins and just slightly lower 2020-2022 revenue CAGR trades at ’21e P/E of 19x, we argue ITE at 20.5x reflect the abovementioned investment case for now. Source: SB1M 2 Only minor estimate changes to 2021e and 2022e Limited ESP estimate changes despite higher sales from expected datacenter transition costs ITE Historical figures New Estimates Old Estimates Delta (%) NOKm 2017 2018 2019 2020 2021 2022 2020 2021 2022 2020 2021 2022 Revenues 475 531 560 619 668 725 619 650 710 0% 3% 2% Expenses -415 -467 -468 -514 -550 -590 -514 -535 -582 0% 3% 1% EBITDA 60 64 92 105 117 136 105 115 128 0% 2% 6% EBITDA-margin 12.6% 12.0% 16.4% 17.0% 17.5% 18.7% 17.0% 17.7% 18.0% DA&I -20 -21 -36 -46 -49 -55 -46 -45 -50 0% 8% 11% EBIT 39 43 56 59 68 80 59 69 78 0% -2% 3% EBIT-margin 8.3% 8.1% 10.0% 9.5% 10.2% 11.1% 9.5% 10.7% 11.0% Pre-tax profit 38 41 54 58 68 80 58 69 78 0% -2% 3% Tax & Minorities -9 -10 -12 -14 -15 -18 -14 -15 -17 0% -1% 4% Net income 30 31 42 44 53 63 44 54 61 0% -3% 2% EPS 0.4 0.4 0.5 0.5 0.6 0.8 0.5 0.7 0.8 0% -3% 2% Revenue break-down 302 335 373 420 460 506 420 449 499 0% 2% 2% Services revenues own consultants 129 135 143 155 162 171 155 162 170 0% 1% 1% Subscriptions 22 39 29 26 26 29 26 23 25 0% 14% 14% 3-party services revenue 21 22 15 18 18 19 18 16 17 0% 16% 16% KPI's CFO 50 57 80 102 108 125 102 105 118 0% 3% 6% Capex -19 -21 -19 -17 -27 -22 -17 -23 -25 0% 16% -11% NIBD -53 -51 -18 -29 -70 -128 -29 -103 -163 0% -32% -22% Source: SB1M, ITE 3 Investment case 4 Framework – what are we looking for? We are looking for four concrete value drivers to create shareholder values 1. Revenue growth 2. Margin expansion 3. Dividends (on top on profitable growth to be reinvested and harvest compound interests) 4. Multiple expansion Source: SB1M 5 Attractive earnings growth profile offset by 21e P/E of ~20.5x We reiterate our Neutral rec. and NOK13 target price based on limited 2021/2022 estimates Itera is a specialist in creating digital business… …positioned with a platform approach and a hybrid delivery model… …which is a demonstrated and world-wide recognizable sourcing model… 1. Revenue growth …where Itera tap into the worlds #4 largest IT pool after US, India & Russia… …positioning the company for further profitable high single-digit growth… …that is supported by high exposure to strong growth industry verticals The ongoing hybrid model roll-out with an increasing nearshore ratio… 2. Margin expansion …and continued datacenter transformation will support margin expansion The business model set the scene for continued high cash conversion… …and consistent high dividend distribution on top of sustainable growth 3. Dividends Peers trades at 2021 P/E of ~19x and EV/EBIT of ~15.5x,… …multiples in the industry is explained by EBIT margin… 4. Multiples …and as ITE delivers median margins with transformation/sales mix upside… 6 …we reiterate our Neutral rec., and NOK13 tp. on limited 2021 estimate changes 1. Revenues Itera is a specialist in creating digital business… +550 employees, 8 offices, strong customer portfolio and hybrid delivery model Source: SB1M, ITE 7 1. Revenues …positioned with a platform approach and a hybrid delivery model… Itera can point to 12 years of seamless nearshoring with first nearshore office opened in 2008 The platform economy Hybrid delivery model with specialized teams Source: SB1M, ITE, Gartner 8 1. Revenues …which is a demonstrated and world-wide recognizable sourcing model… Itera won “the customer experience provider of the year 2018” Minister of Trade of Norway site visit in Kiev Global sourcing association summit 2018 Source: SB1M, ITE, Digi.no, Global Sourcing Association Summit (2018) 9 1. Revenues …where Itera tap into the worlds #4 largest IT pool after US, India & Russia… In addition, Ukraine and Belarus as a region is ranked #2 globally on quality of the labor pool Ukrainian tech talent pool growth (‘000 of people) Ukraine is largest exporter of IT services in Europe 8.4 220 192 160 5.4 5.0 4.5 127 3.6 100 2017 2018 2019 2020e 2025e 2016 2017 2018 2019 2020e Ukrainian IT exports (USDbn) Source: SB1M, ITE, Forbes, ain.ua (2019), Delo.ua (2020), UniCity, Simula Research 10 1. Revenues …positioning the company for further profitable high single-digit growth… Itera has the last 3y demonstrated and is currently experiencing strong operational momentum Revenues and revenue growth history Revenue split per segment • 2014: Ukrainian revolution and closed down Lviv office. • Services revenues = classic consultancy revenues (time & material). • 2015: Sold the data center operation in Sweden in the middle of 2015. • Subscriptions = primarily data center operations (low margin). • 2016: stopped the Swedish consultancy business. • 3-party services revenue = consultancy sub-contractors. 800 30% 800 700 24.0% 25% 700 600 20% 600 500 15% 500 11.7%11.9% 400 10.5% 10% 400 8.6% 7.8% NOKm NOKm 300 6.1% 5.5% 5% 300 YoY growth 1.7% 200 200 -1.0% 0% -2.4% 100 -5.4% -5% 100 0 -10% 0 2013 2014 2015 2016 2017 2018 2019 2020 2021E 2022E Services revenues own consultants Subscriptions Revenues growth (YoY) 3-party services revenue Other (incl. HW/SW) Source: SB1M, ITE 11 1. Revenues …that is supported by high exposure to strong growth industry verticals 64% of sales in Itera steam from Banking & Insurance, which is expected to outgrow the market Comparison of different market CAGR’s Revenue by industry in Itera 5.3% 4.8% 4% Banking & Insurance 4% 5% 3.8% Public, Healthcare and 9% Organizations 3.2% Other Retail & Consumer Products 15% 64% Professional Services Energy and Marine Nordic 2019-2023 IT Global 2019-2023 ICT Global 2017-2023 Global 2017-2023 services spend spending Banking IT spend Insurance IT spend Source: SB1M, ITE, TietoEvry, Gartner, IDC, technologydecisions 12 2. Margins The ongoing hybrid model roll-out with an increasing nearshore ratio… Target is for the nearshore ratio to be in excess of 50%, meaning further EBIT margin potential Trailing 12m nearshore ratio (% of staff nearshore) EBIT margin vs. nearshore ratio 60% 12% 50% 10% 8% 40% 6% 30% EBIT EBIT margin 4% 20% R² = 0.7211 2% 10% 0% 25% 30% 35% 40% 45% 50% 0% Nearshore ratio 2Q14 4Q14 2Q15 4Q15 2Q16 4Q16 2Q17 4Q17 2Q18 4Q18 2Q19 4Q19 2Q20 4Q20 Source: SB1M, ITE 13 2. Margins …and continued datacenter transformation will support margin expansion DCO operation is dilutive on margins and growth, and workload expected fully moved in 2022 EBIT margin DCO vs. blended ITE margin Revenue split per business unit 14% 100% 12% 90% 80% 10% 70% 8% 72%74%75%73%74%73%76% 60% 79%79%77%80%80%81%80%82%81%81%80%81% 6% 50% 4% 40% 2% 30% 20% 0% 28%26%25%27%26%27%24% 1Q17 3Q17 1Q18 3Q18 1Q19 3Q19 1Q20 3Q20 10% 21%21%23%20%20%19%20%18%19%19%20%19% -2% 0% -4% 2Q16 4Q16 2Q17 4Q17 2Q18 4Q18 2Q19 4Q19 2Q20 4Q20 Trailing 12m DCO EBIT margin Trailing 12m blended EBIT margin DCO share of revenue Core Digital Services share of revenues Source: SB1M, ITE 14 3. Dividends The business model set the scene for continued high cash conversion… Norm. cash conversion is ~80% and DCO is capex heavy, i.e. transformation improve cash flow T12m cash conversion (EBITDA-capex/EBITDA) Trailing 12m FCF margin • 2014: Cash conversion dropped to 54% due to issues with the Ukrainian revolution and close of Lviv office (opened office in Slovakia). • 2017: Abnormal high capitalized R&D from Handelsbanken 7y agreement. • 2018/2019: High fixed capex related to new offices in Kiev.